Inside every chief exec, there's a Soviet planner

Saturday 14 February 2009 19.01 EST
First published on Saturday 14 February 2009 19.01 EST

The most remarkable thing on show at last week's banking hearings was the capitalists' naivety about capitalism - a gullibility that has endangered both of the economy's major institutions, markets and companies.

Their credulity about markets has been total. In a forthcoming paper, Professor Brendan McSweeney of the Royal Holloway School of Management argues that "market-failure denial" may have actually helped to provoke the economic holocaust. He notes that, by discounting the evident pitfalls of unrestrained purpose and capital-market-driven myopia, assumptions of market infallibility cleared the way for free markets not to self-correct, as believers predicted they would, but to self-destruct.

Likewise self-interest, another article of capitalist faith, was no more effective as a curb on bankers' capacity to self-harm than on sharks in a feeding frenzy. In the financial Götterdämmerung, hedge funds that had successfully taken down everything else that moved did the same to the banks, only to discover they were destroying the source of the funds they needed to gamble with.

As for companies, the capitalist orthodoxy got it wrong from A to Z. Managers miscalculated risk, misallocated resources and created incentives of such outstanding perversity that they brought the entire global financial system crashing down around them.

How could this happen? One answer is that, in their Tarzan-like celebrations following the Cold War triumph over central planning, the high priests of capitalism neglected to notice the sting that the moribund system had left behind. With exquisite irony, while central planning had been largely discredited at macroeconomic level, at microeconomic level it remained alive and kicking - in their own organisations. Veteran systems thinker Russ Ackoff is not alone in noting that while at the macro level the west is vehemently committed to a market economy, at the micro level almost everyone works in "non-market, centrally planned, hierarchically managed" ones.

The truth is that much conventional management is central planning in western disguise. This is why most companies are zombie-like in their structural and strategic similarity. This is why, too, they are unable to learn. With their faces toward the CEO and their arses towards the customer - in the immortal words of GE's former CEO, Jack Welch - what would they learn from? No wonder warnings of disaster were suppressed or auto-censored at the banks, or that the only messages heard were those that fitted with the earnings targets that managers managed by. In turn, the learning failure explains why so many companies adhere to the Zimbabwe school of change management - altering course only after ruin, by coup d'état.

Central planning imposes a huge co-ordination burden - which is why there's just so much management. If work is fragmented so that people have no direct line of sight to the customer, people have to be driven by signals from above rather than below. So each company has its own little State Planning Committee, a management factory remote from the people doing the real work, where managers devise top-down production schedules, targets, procedures and carrot-and-stick performance management and pay schemes, with complex systems to keep track of it all.

The cost of maintaining the management factory is immense. Consider that the world's most efficient large conventionally managed corporation, GE, spends 40% - that is, $60bn - of its revenues on administration and overheads. For every direct worker there's an indirect one to check or "manage" the work. If anything, overhead costs are increasing as work breeds more work. In less effective organisations, of course, hidden indirect costs are much higher.

None of this adds value for the customer. But although management clearly isn't costless, we weren't expecting the balance sheet to be negative. Yet while capitalists chortle over the absurdities of Soviet-style central planning - not to mention over-management in our own public sector - nothing in the pantheon of Soviet nonsenses (plants making a single giant steel bar or only left-foot shoes) compares, for destructive firepower, with the complex instruments rolling off the production lines of Wall Street and the City of London. Warren Buffett's description of derivatives as weapons of mass destruction was exactly right.

As it turns out, the managers of large western corporations have much more in common with the apparatchiks of the command economies than is recognised. The aim may be different, but they share the same conception of management - faith in targets and incentives, separation of "management" and "work" - and, ultimately, the same neglect of customers and product markets. If capitalism is to be saved, don't expect salvation to come from the capitalists.